Is the Trading World Ripe for Consolidation?

When oil prices fell, traders were the envy of the rest of the industry. Big trading firms were able to boost revenues through nimble strategies, lower costs, favorable spreads, and diversification of their asset bases. But a number of changes in the market have altered the outlook for the likes of Vitol, Trafigura, Glencore, Mercuria, and Gunvor. A decline in volatility and a flatter forward curve have cut dramatically into profit margins, raising questions about future profitability, and whether the large trading houses will continue their growth trajectory by buying up competitors and purchasing more assets.

A decline in volatility and a flatter forward curve have cut dramatically into profit margins, raising questions about future profitability, and whether the large trading houses will continue their growth trajectory by buying up competitors.

One major trading house, Gunvor, is reportedly looking to sell its assets, according to the Wall Street Journal. The company’s CEO Torbjorn Tornqvist, however, told WSJ that it had no plans to put itself up for sale “at this time.” But trading sources tell The Fuse that it wouldn’t be surprising if the Geneva-based firm does indeed get rid of some of its assets given that they are heavily tilted toward Europe, where the refining industry is contracting amid weaker fuel demand and competition from the U.S., the Middle East, and Asia. In a reflection of the difficult times for Gunvor and other merchants, the trading house said net profit fell to $315 million in 2016, from a record $1.25 billion the year before.

Although Tornqvist stated that the company is not up for sale, he said Gunvor, which is in the second tier of trading houses, plans to sell its stake in its Rotterdam terminal. According to trading sources, the firm may want to unload its three refineries in Europe, where more than 2 million barrels per day of capacity has gone offline since late last decade. Gunvor’s plants are located in Antwerp, Rotterdam, and Ingolstadt. The Ingolstadt refinery serves niche areas in Germany and Austria, while the Antwerp and Rotterdam plants can export to the global market. Each faces its own challenges. The Ingolstadt refinery, which is land-locked, is dependent on demand in markets where consumption has likely peaked and margins have been dismal at times. The Antwerp and Rotterdam refineries, while serving Europe, can also send refined products to global markets. But their market power is limited. New export refineries built in the Middle East, along with capacity growth in the Asia-Pacific region and high volumes shipped from the U.S. Gulf Coast, have undercut opportunities for European refineries like Gunvor’s.

New export refineries built in the Middle East, along with capacity growth in the Asia-Pacific region and high volumes shipped from the U.S. Gulf Coast, have undercut opportunities for European refineries like Gunvor’s.

Gunvor’s European woes aren’t replicated worldwide. Besides its refining assets, Gunvor also owns pipelines, terminals, oil upstream operations in the Caspian, Africa, and Europe, and coal resources. But the firm has a small footprint in the U.S., the epicenter of growth in crude supply and high downstream margins, compared to other merchants. Its presence here is growing—it began inking U.S. crude export deals in March of last year and borrowed $500 million in late 2016 to fund American trading operations. Gunvor has set up offices in Houston and Connecticut, and Tornqvist said the firm plans to focus on increasing its U.S. operations in 2017, signs that the company is trying to play catch-up to others: It saw trading volumes grow last year by 600,000 barrels per day to 2.5 mbd of crude and products.

Growth despite margins getting cut

With volatility shrinking and the contango—when prices along the curve are higher than the prompt month—narrowing, trader profitability has taken a hit. “When the contango was deeper, they [traders] could push barrels all over the place,” one trading source told The Fuse. Traders were able to store crude at a profit and take advantage of arbitrage opportunities between regions and crude and products, but those options have dwindled as the curve has flattened, making the high-risk business even more competitive. Vitol, the largest merchant, said its margins fell to 21 cents per barrel last year, about a third of levels seen in 2015.

Despite the tougher environment, merchants are expanding their trading volumes and dealing in countries with high geopolitical risk.

Despite the tougher environment, merchants are expanding their trading volumes and dealing in countries with high geopolitical risk. Vitol trades more than 7 mbd of crude and refined products after significant increases last year, while Glencore boosted volumes by 45 percent to 4.8 mbd in 2016 and Trafigura saw a similar increase to 4.4 mbd. “Demand growth of 1.4 mbd exceeded our expectations slightly, but the continued efficiency gains within the exploration sector ensured the market was supplied and the impact on price constrained,” Vitol said last month in a review.

Traders are doing oil-for-cash deals in Libya, with the Kurdistan Regional Government, and in Russia, among others. Vitol, after purchasing petrol stations in Turkey recently, said it is looking for assets to complement its core trading business. The merchants will also be active in the U.S. to take advantage of opportunities for crude export—which rose to about 1 mbd in February. Castleton, a second-tier trader which is trying to grow, is diving into the crude market in Texas. For instance, last year it bought midstream and upstream assets from Anadarko for $1 billion.

Until recently, merchants typically operated in the shadows of the oil markets, exploiting opportunities under the radar, but have become increasingly public about their operations and performance. At the same time, there are also small firms that mostly rely more on trading margins than holding upstream and downstream assets. If profits continue to get squeezed, they may fold or get snapped up. The issues for Gunvor, a large trader but still below the top merchants, could be reflective of wider problems in the oil trading business. Against this backdrop, challenges facing the smaller and less flexible players will make the trading world ripe for consolidation. The big players can be expected to aggressively explore opportunities to grow in order to diversify their asset and customer bases and mitigate risk.

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The Fuse is an energy news and analysis site supported by Securing America’s Future Energy. The views expressed here are those of individual contributors and do not necessarily represent the views of the organization.

Issues in Focus

Safety Standards for Crude-By-Rail Shipments

A series of accidents in North America in recent years have raised concerns regarding rail shipments of crude oil. Fatal accidents in Lynchburg, Virginia, Lac-Megantic, Quebec, Fayette County, West Virginia, and (most recently) Culbertson, Montana have prompted public outcry and regulatory scrutiny.

2014 saw an all-time record of 144 oil train incidents in the U.S.—up from just one in 2009—causing a total of more than $7 million in damage.

The spate of crude-by-rail accidents has emerged from the confluence of three factors. First is the massive increase in oil movements by rail, which has increased more than three-fold since 2010. Second is the inadequate safety features of DOT-111 cars, particularly those constructed prior to 2011, which account for roughly 70 percent of tank cars on U.S. railroads. Third is the high volatility of oil produced from the Bakken and other shale formations, which makes this crude more prone towards combustion.

Of these three, rail car safety standards is the factor over which regulators can exert the most control. After months of regulatory review, on May 1, 2015, the White House and the Department of Transportation unveiled the new safety standards. The announcement also coincided with new tank car standards in Canada—a critical move, since many crude by rail shipments cross the U.S.-Canadian border. In the words DOT, the new rule:

Since the rule was announced, Republicans in Congress sought to roll back the provision calling for an advanced breaking system, following concerns from the rail industry that such an upgrade would be unnecessary and could cost billions of dollars. The advanced braking systems are required to be in place by 2021.

Democrats in Congress have argued that the new rules are insufficient to mitigate the danger. Senator Maria Cantwell (D-WA) and Senator Tammy Baldwin (D-WI) both issued statements arguing that the rules were insufficient and the timelines for safety improvements were too long.

The current industry standard car, the CPC-1232, came into usage in October 2011. These cars have half inch thick shells (marginally thicker than the DOT-111 7/16 inch shells) and advanced valves that are more resilient in the event of an accident. However, these newer cars were involved in the derailments and explosions in Virginia and West Virginia within the past year, raising questions about the validity of replacing only the DOT-111s manufactured before 2011.

Before the rule was finalized, early reports indicated that the rule submitted to the White House by the Department of Transportation has proposed a two-stage phase-out of the current fleet of railcars, focusing first on the pre-2011 cars, then the current standard CPC-1232 cars. In the final rule, DOT mandated a more aggressive timeline for retrofitting the CPC-1232 cars, imposing a deadline of April 1, 2020 for non-jacketed cars.

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DataSpotlight

The recent oil production boom in the United States, while astounding, has created a misleading narrative that the United States is no longer dependent on oil imports. Reports of surging domestic production, calls for relaxation of the crude oil export ban, labels of “Saudi America,” and the recent collapse in oil prices have created a perception that the United States has more oil than it knows what to do with.

This view is misguided. While some forecasts project that the United States could become a self-sufficient oil producer within the next decade, this remains a distant prospect. According to the April 2015 Short Term Energy Outlook, total U.S. crude oil production averaged an estimated 9.3 million barrels per day in March, while total oil demand in the country is over 19 million barrels per day.

This graphic helps illustrate the regional variations in crude oil supply and demand. North America, Europe, and Asia all run significant production deficits, with the Middle East, Africa, Latin America, and Former Soviet Union are global engines of crude oil supply.